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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [Fee Required]
For the Fiscal Year Ended December 31, 2000
[ ] TRANSITION REPORT PURSUANT SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [No Fee Required]
For the transition period from___________to__________
Commission File Number 2-91196(1)
NORTHERN EMPIRE BANCSHARES
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(Exact name of registrant as specified in its charter)
CALIFORNIA 94-2830529
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(State or other jurisdiction of (I.R.S. Employer Identification
incorporation or organization) Number)
801 Fourth Street
Santa Rosa, California 95404
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(Address of principal executive offices)
(707) 579-2265
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(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Exchange Act:
NONE
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter
period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days. Yes
X No_____.
Indicate by check mark if disclosure of delinquent filers pursant
to Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. [X]
State the aggregate market value of the voting stock held by
nonaffiliates of the registrant. The aggregate market value shall be
computed by reference to the price at which the common equity was sold,
or the average bid and asked prices of such common equity, as of a
specified date within 60 days prior to the date of filing. $81,467,316,
as of February 15, 2001.
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date: 3,768,146
shares of common stock as of February 15, 2001.
DOCUMENTS INCORPORATED BY REFERENCE:
Not Applicable.
(1) Registrant filed a registration statement, on Form S-1, under File
Number 2-91196, and the Post Effective Amendment No. 8 to the
registration statement was declared effective on November 23, 1988.
TABLE OF CONTENTS
Part I
Item 1. Business
Item 2. Properties
Item 3. Legal Proceedings
Item 4. Submission of Matters to a Vote of Security Holders
Part II
Item 5. Market for Registrant's Common Equity and Related Stockholder
Matters
Item 6. Selected Financial Data
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Item 8. Financial Statements and Supplementary Data
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure
Part III
Item 10. Directors and Executive Officers of the Registrant
Item 11. Executive Compensation
Item 12. Security Ownership of Certain Beneficial Owners and
Management
Item 13. Certain Relationships and Related Transactions
Part IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.
PART 1
Forward-Looking Statements
This report contains "forward-looking statements" as defined in section
27A of the Securities Act of 1933, as amended, and section 21E of the
Securities Exchange Act of 1934, as amended, which includes statements
such as projections, plans and objectives and assumptions about the
future, and such forward looking statements are subject to the safe
harbor created by these sections. Many factors could cause the actual
results, amounts or events to differ materially from those the
Corporation expects to achieve or occur, such as changes in competition,
market interest rates, economic conditions and regulations. Although
the Corporation has based its plans and projections on certain
assumptions, there can be no assurances that its assumptions will be
correct, or that its plans and projections can be achieved.
ITEM 1. Business
General
Northern Empire Bancshares (the "Corporation") was incorporated as a
California corporation on June 8, 1982 for the purpose of becoming a
bank holding company of Sonoma National Bank (the "Bank"). On April 27,
2000, the Corporation made an election to become a financial holding
company pursuant to the Gramm-Leach-Bliley Act of 1999. The
Corporation's executive offices are located at 801 Fourth Street, Santa
Rosa, California, and its telephone number is (707) 579-2265.
The Corporation's sole subsidiary is the Bank and its activities are the
commercial banking activities engaged in through the Bank and some
lending. As a financial holding company, the Corporation may in the
future invest in subsidiaries which are permissible for a financial
holding company, subject to the required approvals of the Federal
Reserve Board. See, "Financial Services Modernization, below."
However, the Corporation has no present plans to make any such
additional investments and there can be no assurance that it will do so
in the future.
The Bank was organized as a national banking association on March 27,
1984 and commenced operations on January 25, 1985. It currently has six
banking offices:
Main Office located at 801 Fourth Street, in the central
business district of Santa Rosa, California,
Oakmont Branch located in the Oakmont area of Santa Rosa,
approximately 5 miles east of the main office,
West College Branch office in west Santa Rosa,
Windsor Branch located in Windsor, approximately 5 miles north
of the main office,
Sebastopol Branch office located in Sebastopol, approximately
5 miles west of the main office, and
Petaluma Branch located in Petaluma, approximately 15 miles
south of the main office.
As a national bank, the Bank is subject to supervision, regulation and
regular examination by the Comptroller of the Currency ("Comptroller").
The deposits of the Bank are insured by the Bank Insurance Fund, which
is administered by the Federal Deposit Insurance Corporation. The Bank
is a member of the Federal Reserve System and, as such, is subject to
applicable provisions of the Federal Reserve Act and the regulations
thereunder. See, "Supervision and Regulation."
The Bank engages in the general commercial banking business. It accepts
checking and savings deposits, offers money market deposit accounts and
certificates of deposit, makes secured and unsecured commercial,
construction, other installment and term loans, and offers other
customary banking services. The Bank makes commercial loans guaranteed
by the Small Business Administration (SBA), which may be sold in the
secondary market. The Bank does not offer trust services directly, and
does not presently intend to do so, but offers such services, when
requested, through its correspondent banks.
Within the Loan Department are groups of lenders which specialize in
commercial, construction and SBA lending. SBA loans are funded by the
Bank and then the Bank may, at its option, sell the portion of the loan
guaranteed by the SBA (generally 70% to 90% of the total loan amount,
depending on the purpose and term of the loan). When a SBA loan is
sold, the Bank retains the unguaranteed portion of that loan and the
right to service the loan. Income from loan sales is recorded in
non-interest income. See, "Management's Discussion and Analysis of
Financial Condition and results of Operations, Non-Interest Income." The
Bank is designated as a "Preferred Lender" by the SBA. This means that
it may fund a loan without the prior approval of the SBA. Certification
as a Preferred Lender gives the Bank a competitive advantage, as it is
able to provide a quick response to loan applications.
Market Area
The Bank's primary market area and source of most of its loan business,
except for SBA lending, is Sonoma County and the greater Bay Area.
During 2000, SBA loans were generated throughout California and in
Arizona and New Mexico. The Bank has expanded its lending territory for
construction loans, commercial real estate loans and loans made under
the programs of the SBA. The Bank has SBA loan production facilities in
Phoenix, Arizona and San Francisco, Sacramento, and Walnut Creek,
California. The Albuquerque, New Mexico office was closed on December
31, 2000 due to slow growth in that market. The primary market area for
deposit business is Sonoma County.
Competition
The banking business in California generally, and specifically in the
market area served by the Bank, is highly competitive with respect to
both loans and deposits, and is dominated by major banks which have
offices operating throughout California. Among the advantages such
major banks have over the Bank are their ability to finance wide-ranging
advertising campaigns and to allocate their investment assets to regions
of highest yield and demand. In addition, many of the major banks
operating in the Bank's service area offer specialized services, such as
trust and international banking services, which the Bank does not offer
directly. By virtue of their greater total capitalization, the major
banks also have substantially higher lending limits than the Bank has.
The Bank competes for loans and deposits with these major banks, as well
as with other independent banks, savings and loan associations, credit
unions, mortgage companies, insurance companies and other lending
institutions. The entry of other independent banks in the Bank's
service area may adversely affect the Bank's ability to compete.
Savings and loans, credit unions and money market funds have provided
significant competition for banks with respect to deposits. Other
entities, both governmental and private, seeking to raise capital
through the issuance and sale of debt or equity securities, also provide
competition for the Bank in the acquisition of deposits. The trend of
federal and state legislation has significantly increased competition
between banks and other financial institutions for both loans and
deposits and is expected to continue to do so in the future. In
particular, the Gramm-Leach-Bliley Act enacted in November, 1999
authorizes affiliations among banks, insurance companies and securities
firms and is expected to significantly increase competition among
financial institutions with respect to all types of financial products
and services.
The earnings and growth of the Bank are affected not only by local
market conditions and general economic conditions, but also by
government monetary and fiscal policies. Such policies influence the
growth of loans, investments and deposits and also affect interest rates
charged on loans and paid on deposits. The nature and impact of future
changes in such policies on the business and earnings of the Bank cannot
be predicted.
At present, there are approximately 115 banking offices and offices of
savings and loan associations in the Sonoma County market area and a
substantially greater number of such offices in the greater Bay Area,
including offices of major chain banks, of smaller independent banks and
savings and loan associations. The Bank attempts to compete by offering
personalized and specialized services to its customers. In the Sonoma
County market area, the Bank's promotional activities emphasize the
advantages of doing business with a locally owned, independent
institution attuned to the particular needs of the community.
The Bank has experienced increased competition from major banks and
local community banks in making SBA loans, especially in California.
Most of our local SBA competitors also have Preferred Lender status from
the SBA, and they often offer more attractive rates on SBA loans than
the Bank can. We expect this trend to continue. There can be no
assurance that the Bank will continue to increase its SBA loan portfolio
or continue to make a significant number of SBA loans.
Certain statistical information concerning the Bank and the Corporation
is provided at "Item 7-Management's Discussion and Analysis of Financial
Condition and Results of Operation".
Employees
At December 31, 2000 the Bank had 89 full-time and 21 part-time
employees.
Supervision and Regulation
The Corporation
The Corporation is a bank holding company registered under the Bank
Holding Company Act of 1956 and is subject to the supervision of the
Board of Governors of the Federal Reserve System ("Board"). As a bank
holding company, the Corporation must obtain the approval of the Board
before it may acquire all or substantially all of the assets of any
bank, or ownership or control of the voting shares of any bank if, after
giving effect to such acquisition of shares, the Corporation would own
or control more than 5% of the voting shares of such bank. Prior
approval of the Board is also required for the merger or consolidation
of the Corporation and another bank holding company. Effective April
27, 2000, the Corporation made an election to become a "financial
holding company" pursuant to the Gramm-Leach-Bliley Act. See Financial
Services Modernization," below.
The Board has the authority to examine the Corporation periodically.
The Board has a policy for risk-focused supervision of small bank
holding companies that do not engage in significant non-banking
activities. The focus of examinations under the policy is on whether
the Corporation has in place systems to manage the risks it takes on in
its business. In analyzing risk, the Board looks at the financial
condition of the Corporation and the Bank, management, compliance with
laws and regulations, inter-company transactions and any new or
contemplated activities.
The Corporation and any subsidiary which it may acquire or organize in
the future are deemed to be affiliates of the Bank within the meaning
set forth in the Federal Reserve Act and are subject to that Act. This
means, for example, that there are limitations on loans by the Bank to
affiliates, on investments by the Bank in any affiliate's stock and on
the Bank's taking any affiliate's stock as collateral for loans to any
borrower. All affiliate transactions must satisfy certain limitations
and otherwise be on terms and conditions that are consistent with safe
and sound banking practices. In this regard, the Bank generally may not
purchase from any affiliate a low-quality asset (as that term is
defined in the Federal Reserve Act). Also, transactions by the Bank
with an affiliate must be on substantially the same terms as would be
available for non-affiliates.
The Corporation and the Bank are prohibited from engaging in certain
tie-in arrangements in connection with the extension of credit. For
example, the Bank generally may not extend credit on the condition that
the customer obtain some additional service from the Bank or the
Corporation, or refrain from obtaining such service from a competitor.
(a) Financial Services Modernization. Major financial services
modernization legislation was enacted in November 1999, known as the
Gramm-Leach-Bliley Act ("1999 Act"). This legislation has removed
barriers that have heretofore separated banks, securities firms and
other types of financial institutions. Effective March 11, 2000, the
1999 Act establishes a new type of holding company, a "financial holding
company," that may engage in "financial activities" not permitted to
bank holding companies and that have the authority to affiliate with
companies engaged in such activities. "Financial activities" are to be
determined by the Board in coordination with the Secretary of the
Treasury, and may include activities that are financial in nature,
incidental to an activity that is financial in nature, or complimentary
to a financial activity and that do not pose a safety and soundness
risk. The 1999 Act enumerates activities considered financial in nature
(in addition to those already permitted to bank holding companies),
including underwriting insurance or annuities, or acting as an insurance
or annuity principal, agent or broker; providing investment or financial
advice; underwriting, dealing in or making markets in securities; and
merchant banking (subject to certain limitations).
A holding company may elect to be treated as a financial holding
company, and engage in these activities, provided that its subsidiary
depository institutions are well-capitalized, well-managed and have
received at least a satisfactory rating in the last Community
Reinvestment Act examination. National banks may also engage in many of
these activities through a new structure, the "financial subsidiary,"
subject to substantially the same capital, management and CRA
requirements, and state-chartered banks are given similar authority.
The Act also provides for functional regulation of financial services
firms, which means that securities activities are to be regulated by the
Securities and Exchange Commission, insurance activities by state
insurance regulators, and banking activities by the appropriate bank
regulatory agencies.
The 1999 Act has resulted or is expected to result in new or revised
regulations for such matters as (1) newly authorized activities for bank
holding companies and financial holding companies, (2) financial
privacy, (3) customer protections for bank insurance sales, (4) the
Community Reinvestment Act, (5) overseas activities of bank holding
companies, (6) bank derivatives transactions and intra-day credit, (7)
activities allowed in national bank operating subsidiaries, and (8)
broker-dealer registration requirements for bank sales of "new hybrid
products.
(b) Dividends Payable by the Corporation Holders of Common Stock of
the Corporation are entitled to receive dividends as and when declared
by the Board of Directors out of funds legally available therefor under
the laws of the State of California. Under California law, the
Corporation is prohibited from paying dividends unless: (a) the amount
of its retained earnings immediately prior to the dividend payment
equals or exceeds the amount of the dividend; or (b) immediately after
giving effect to the dividend (i) the sum of its assets would be at
least equal to 125 percent of its liabilities and (ii) its current
assets would be at least equal to its current liabilities, or, if the
average of its earnings before taxes on income and before interest
expense for the two preceding fiscal years was less than the average of
its interest expense for the two preceding fiscal years, at least equal
to 125 percent of its current liabilities.
The Board of Governors has advised bank holding companies that it
believes that payment of cash dividends in excess of current earnings
from operations is inappropriate and may be cause for supervisory
action. As a result of this policy, banks and their holding companies
may find it difficult to pay dividends out of retained earnings from
historical periods prior to the most recent fiscal year or to take
advantage of earnings generated by extraordinary items such as sales of
buildings or other large assets in order to generate profits to enable
payment of future dividends. Further, the Board of Governors' position
that holding companies are expected to provide a source of managerial
and financial strength to their subsidiary banks potentially restricts a
bank holding company's ability to pay dividends.
The Corporation's ability to pay dividends on its Common Stock is
subject to the rights of senior security holders and lenders, which will
include the holders of preferred stock in the future if preferred stock
is issued. Dividend payments will also be dependent upon its separate
liquidity needs. See Item 7, "Management's Discussion and Analysis of
Financial Condition." In that regard, Federal and state statutes,
regulations and policies impose restrictions on the payment of
management fees and cash dividends by the Bank to the Corporation.
Information regarding the Company's cash dividend payment history can be
found in Item 5, "Market for Common Equity and Related Stockholder
Matters."
The Bank
As a national banking association, the Bank is subject to the National
Bank Act and to supervision, regulation and regular examination by the
Comptroller of the Currency ("Comptroller"). It is also a member of the
Federal Reserve System and, as such, is subject to applicable provisions
of the Federal Reserve Act and regulations issued pursuant thereto. The
deposits of the Bank are insured up to the maximum legal limits by the
Bank Insurance Fund ("BIF"), which is managed by the Federal Deposit
Insurance Corporation ("FDIC"), and the Bank is therefore subject to
applicable provisions of the Federal Deposit Insurance Act and
regulations of the FDIC. The statutes and regulations administered by
these agencies govern most aspects of the Bank's business, including
required reserves against deposits, loans, investments, dividends, and
the establishment of new branches and other banking facilities.
(a) Supervision and Examinations. Federal law mandates frequent
examinations of all banks, with the costs of examinations to be assessed
against the bank being examined. In the case of the Bank, its primary
regulator is the Comptroller.
The Comptroller has a community bank risk-assessment system, which
consists of examination procedures that focus on the various types of
risks that national banks face. The Comptroller measures each
individual bank's exposure to certain risks, assesses the controls the
bank has adopted in response to the risks it faces and the measures it
takes to monitor those risks. The Comptroller evaluates nine categories
of risk: credit, interest rate, liquidity, price, foreign exchange,
transaction, compliance, strategic and reputation. These nine risks are
measured and the direction of the risk is also analyzed.
The FDIC has "back up" enforcement power over the Bank under Federal
law. The FDIC may recommend and, in the absence of response by an
institution's primary regulator, undertake enforcement action against
any insured financial institution. Such "back up" enforcement action is
permissible if ordered by the Board of Directors of the FDIC only upon a
showing that an insured financial institution's conduct poses a risk to
its insurance fund.
The Federal banking regulatory agencies have substantial enforcement
powers over the depository institutions that they regulate. Civil and
criminal penalties may be imposed on such institutions and persons
associated with those institutions for violations of any law or
regulation. The penalties can be up to $ 5,000 per day that a violation
continues when the violation is unintentional, or up to $1 million per
day that a violation continues when the violation is willful. The amount
of the penalty also depends on whether the violation is part of a
pattern or causes a loss to the financial institution.
(b) Prompt Corrective Action. The Federal Deposit Insurance
Corporation Improvement Act of 1991 ("FDICIA") requires the banking
agencies to take corrective action against certain financial
institutions, based upon the financial institutions' compliance with the
various capital measurements. The capital requirements and the
definitions of the various measures of capital are described below under
the heading "Capital Regulations and Dividends." The following chart
sets forth the various categories of capital compliance. In order to be
considered in the well or adequately capitalized categories, a financial
institution must meet all the requirements for that category. An
institution will be considered undercapitalized or significantly or
critically undercapitalized if it meets any of the requirements for that
category.
Ratio Category Total Risk-Based Tier 1 Risk-Based Leverage
- ---------------- ---------------- ----------------- ----------
Well Capitalized* 10% or above 6% or above 5% or above
Adequately
Capitalized 8% or above 4% or above 4% or above**
Undercapitalized Less than 8% Less than 4% Less than 4%
Significantly
Undercapitalized Less than 6% Less than 3% Less than 3%
Critically
Undercapitalized - - 2% or less
* In addition, the institution must not be subject to any written
capital order or directive to meet and maintain a specific capital
level.
** 3% instead of 4% if the institution has the highest rating under
the CAMEL rating system.
FDICIA also permits the banking agencies essentially to downgrade an
institution to the next lower category (but not into the category of
critically undercapitalized) if it determines that the institution is in
an unsafe or unsound condition, or is engaging in an unsafe or unsound
practice. An institution that has received a less-than-satisfactory
rating in its most recent examination report for assets, management,
earnings or liquidity may be deemed to be engaged in an unsafe and
unsound practice. Except for a finding based on a
less-than-satisfactory rating, the institution is entitled to prior
written notice and an opportunity to respond to its regulator's finding
that it is in an unsafe or unsound condition or is engaging in such
practices.
Based on its capital position at December 31, 2000, the Bank is
considered well capitalized.
As noted above, an undercapitalized financial institution is subject to
certain corrective action by the appropriate agency, depending on the
category it falls into. All undercapitalized institutions are required
to submit a capital plan within 45 days after the institution becomes
undercapitalized. Also, such an institution's asset growth is
restricted and it must obtain the prior approval of its federal
regulator before it acquires any company, sets up any new branch or
engages in any new line of business. The banking agency is required to
monitor closely the condition of the bank and its compliance with its
plan, and to review periodically the plan and the supervisory
restrictions on the bank to assure they are appropriate. In addition,
the regulator is authorized by statute to take the certain corrective
actions and order certain limitations on the bank's activities if
necessary to carry out the purposes of the statute.
If an institution is categorized as being significantly
undercapitalized, or is undercapitalized and fails to submit a capital
plan, its banking regulator is required to take increasingly severe
enforcement actions against such institution. The regulator must
require recapitalization through a sale of stock or a merger, restrict
affiliate transactions and restrict the interest rates the bank may
offer on deposits, (unless it finds that doing so would not further the
purpose of the section). In addition, such an institution may not pay a
bonus to a senior executive officer or increase the pay of any executive
officer without the prior written approval of its federal regulator.
An institution that is critically undercapitalized is subject to
mandatory restrictions that are even more severe, and seizure within
time limits designated by statute. In general, the federal regulator is
required to seize an institution within 90 days of its becoming
critically undercapitalized, unless the regulator can document that
another course of action will better achieve the purposes of this
section. The FDIC is required to restrict the activities of a
critically undercapitalized institution, beyond the degree of
limitations specified above for institutions that are significantly
undercapitalized.
(c) Brokered Deposits. FDICIA places limits on brokered deposits and
extends the limits to any bank that is not "well capitalized" or is
notified that it is in "troubled condition." Previously, the
limitations applied only to troubled banks. A well capitalized
institution (which generally includes an institution that is considered
well capitalized for purposes of the prompt corrective action
regulations discussed above) may still accept brokered deposits without
restriction, unless it has been informed by its appropriate Federal
regulatory agency that it is in "troubled condition." All other insured
depository institutions are prohibited from accepting brokered deposits
unless a waiver is obtained from the FDIC. If a waiver is obtained, the
interest paid on such deposits may not exceed the rate paid for deposits
in its normal market area, or the national rate as determined in the
FDIC's regulation.
If a depository institution solicits deposits by offering interest rates
significantly higher than rates being offered in its market area, it is
deemed under FDICIA to be a deposit broker. Therefore, depending on its
capital category, it may be prohibited from such practice, or need a
prior waiver from the FDIC in order to offer such rates. The FDIC's
regulations specify that an institution that is not well capitalized may
offer rates that exceed the prevailing effective rates offered in the
normal market area only if the institution obtains a waiver, but the
institution may not offer rates more than 75 basis points above such
prevailing rates.
The Bank is at this time considered well capitalized and not in a
"troubled condition," and it is not, therefore, subject to the brokered
deposit limitations.
(d) Risk-Based Deposit Insurance Assessments. In addition, FDICIA
required the FDIC to develop and implement a system to account for risks
attributable to different categories and concentrations of assets and
liabilities in assessing deposit insurance premiums. Under this system,
each bank's deposit insurance premium assessment is calculated based on
the level of risk that the Bank Insurance Fund will incur a loss if that
bank fails and the amount of the loss if such failure occurs. This
requirement, along with the increased emphasis on exceeding capital
measures, may cause banks such as the Bank to adjust their asset mix in
order to affect their deposit insurance premium and their ability to
engage in activities.
Capital Regulations and Dividends
The Board requires member banks and bank holding companies to maintain
adequate capital and has adopted capital leverage guidelines for
evaluating the capital adequacy of bank holding companies. The
Comptroller has also adopted a similar minimum leverage regulation,
requiring national banks to maintain at least a minimum capital to asset
ratio. The Board's guidelines and the Comptroller's regulations require
the banks and bank holding companies subject to them to achieve and
maintain a Tier 1 capital to total asset ratio of at least three percent
(3.0%) to five percent (5.0%), depending on the condition and rate of
growth of the bank or holding company. Tier 1 or core capital is
defined to consist primarily of common equity, retained earnings, and
certain qualified perpetual preferred stock. These minimum leverage
ratio requirements limit the ability of the banking industry, including
the Corporation and the Bank, to leverage assets.
The Federal Reserve Board also uses risk-based capital guidelines to
evaluate the capital adequacy of member banks and bank holding
companies. Under these guidelines, assets are categorized according to
risk and the various categories are assigned risk weightings. Assets
considered to present less risk than others require allocation of less
capital. In addition, off-balance sheet and contingent liabilities and
commitments must be categorized and included as assets for this purpose.
Under these guidelines, the Corporation is required to maintain total
capital of at least 8.00% of risk-adjusted assets, and half of that
minimum total capital must consist of Tier 1 capital as defined above.
The Comptroller has also adopted risk-based capital guidelines
applicable to national banks, such as the Bank, that are similar to the
Federal Reserve's risk-based capital guidelines. At this time, the Bank
is required to maintain total capital of at least 8.00% of risk-adjusted
assets.
The capital totals of the Corporation and the Bank, as of December 31,
2000, exceeded the amounts of capital required under the regulatory
guidelines. The following table shows the capital of the Corporation
and the Bank, as a percentage of assets, and the capital which they are
required to maintain under the capital regulations, as of December 31,
2000:
Corporation Bank
Leverage capital ratio 7.5% 7.4%
Required leverage capital ratio 3.0% - 5.0%* 3.0% - 5%*
Total risk-based capital ratio 10.7% 10.6%
Required total risk-based capital ratio 8.0% 8.0%
Tier 1 risk-based capital ratio 9.5% 9.4%
Required tier 1 risk-based capital ratio 4.0% 4.0%
* Determined based on the regulators' evaluations.
Under the risk-based capital rules, when the agencies assess the capital
adequacy of a bank, they must take into account the effect on that
bank's capital that would occur if interest rates moved up or down. The
purpose of this requirement is to ensure that banks with high levels of
interest rate risk have enough capital to cover the loss exposure.
The risk-based guidelines and the leverage ratio do not have a
significant effect on the Corporation and the Bank at this time because
both the Corporation and the Bank meet their respective required ratios.
The effect the requirements may have in the future is uncertain, but
management does not believe they will have an adverse effect on the
Corporation or the Bank. The risk-based capital guidelines may affect
the allocation of the Bank's assets between various types of loans and
investments. If the Bank continues to grow with its present asset
composition, it may be required to raise additional capital.
The required capital ratios have increased in significance under FDICIA,
as described above. The ratios now affect the Bank's ability to utilize
brokered deposits and its deposit insurance premium rates, and they can
result in regulatory enforcement action. See, above, "The Bank."
As required by FDICIA, the Federal banking agencies now take credit risk
concentrations and an individual institution's ability to manage such
concentrations into account when they assess a bank's capital adequacy.
Non-traditional investments and activities, such as the use of
derivatives, are also taken into account in assessing capital
requirements. The agencies can adjust the standards for risk-based
capital on a case by case basis to take such risks into account, but
there is no formula that a bank can use prior to evaluation by the
agency to determine how credit concentration or nontraditional
activities will affect its capital requirements.
Regulatory restrictions and other information guidelines with respect to
the payment of dividends by the Bank are contained in Item 5, "Market
for Common Equity and Related Stockholder Matters.", below.
Impact of Monetary Policies
Banking is a business in which profitability depends on rate
differentials. In general, the difference between the interest rate
received by the Bank on loans extended to its customers and securities
held in the Bank's investment portfolio and the interest rate paid by
the Bank on its deposits and its other borrowings comprise the major
portion of the Bank's earnings. To the extent that the Bank is not able
to compensate for increases in the cost of deposits and other borrowings
with greater income from loans, securities and fees, the net earnings of
the Bank will be reduced. The interest rates paid and received by the
Bank are highly sensitive to many factors which are beyond the control
of the Bank, including the influence of domestic and foreign economic
conditions.
The earnings and growth of the Bank are also affected by the monetary
and fiscal policy of the United States government and its agencies,
particularly the Board. These agencies can and do implement national
monetary policy, which is used in part to curb inflation and combat
recession. Among the instruments of monetary policy used by these
agencies are open market transactions in United States Government
securities, changes in the discount rates of member bank borrowings and
changes in reserve requirements. The actions of the Board have had a
significant effect on lending by banks, investments and deposits, and
such actions are expected to continue to have a substantial effect in
the future. However, the nature and timing of any further changes in
such polices and their impact on the Bank cannot be predicted.
Public Interest Laws, Consumer and Lending Laws
In addition to the other laws and regulations discussed herein, the Bank
is subject to certain consumer and public interest laws and regulations
that are designed to protect customers in transactions with banks.
While the list set forth below is not exhaustive, these laws and
regulations include the Community Reinvestment Act, Truth in Lending
Act, the Truth in Savings Act, the Electronic Funds Transfer Act, the
Expedited Funds Availability Act, the Equal Credit Opportunity Act, the
Fair Housing Act, the Real Estate Settlement Procedures Act, the Home
Mortgage Disclosure Act, the Fair Credit Reporting Act, the Fair Debt
Collection Practices Act, the Bank Secrecy Act and the Right to
Financial Privacy Act.
These laws and regulations mandate certain disclosure requirements and
regulate the manner in which financial institutions must deal with
customers when taking deposits, making loans, collecting loans and
providing other services. The Bank must comply with the applicable
provisions of these laws and regulations as part of its ongoing customer
relations. Failure to comply with these laws and regulations can
subject the Bank to various penalties, including but not limited to
enforcement actions, injunctions, fines or criminal penalties, punitive
damages to consumers and the loss of certain contractual rights.
Environmental Regulation
Federal, state and local regulations regarding the discharge of
materials into the environment may have an impact on the Corporation and
the Bank. Under Federal law, liability for environmental damage and the
cost of cleanup may be imposed upon any person or entity who is an owner
or operator of contaminated property. State law provisions, which were
modeled after Federal law, impose substantially similar requirements.
Both Federal and state laws were amended in 1996 to provide generally
that a lender who is not actively involved in operating the contaminated
property will not be liable to clean up the property, even if the lender
has a security interest in the property or becomes an owner of the
property through foreclosure.
The Economic Growth and Regulatory Paperwork Reduction Act of 1996 (the
"Economic Growth Act"), discussed in more detail below, includes
protection for lenders from liability under the Comprehensive
Environmental Response, Compensation and Liability Act of 1980
("CERCLA"). The Economic Growth Act adds a new section to CERCLA to
specify the actions a lender may take with respect to lending and
foreclosure activities without incurring environmental clean-up
liability or responsibility. Typical contractual provisions regarding
environmental issues in the loan documentation and due diligence
inspections will not lead to lender liability for clean-up, and a lender
may foreclose on contaminated property, so long as it merely maintains
the property and moves to divest it at the earliest possible time.
Under California law, a lender generally will not be liable to the State
Attorney General for the cost associated with cleaning up contaminated
property unless the lender realized some benefit from the property,
failed to divest the property promptly, caused or contributed to the
release of the hazardous materials or made the loan primarily for
investment purposes. This amendment to California law became effective
with respect to judicial proceedings filed and orders issued after
January 1, 1997.
The extent of the protection provided by both the Federal and state
lender protection statutes will depend on their interpretation by the
administrative agencies and courts, and the Corporation cannot predict
whether it will be adequately protected for the types of loans made by
the Bank.
In addition, the Corporation and the Bank are still subject to the risks
that a borrower's financial position will be impaired by liability under
the environmental laws and that property securing a loan made by the
Bank may be environmentally impaired and not provide adequate security
for the Bank. California law provides some protection against the
second risk, by establishing certain additional, alternative remedies
for a lender in the situation where the property securing a loan is
later found to be environmentally impaired. Primarily, the law permits
the lender in such a case to pursue remedies against the borrower other
than foreclosure under the deed of trust.
The Bank attempts to protect its position against the remaining
environmental risks by performing prudent due diligence. Environmental
questionnaires and information on use of toxic substances are requested
as part of its underwriting procedures. The Bank lends based upon its
evaluation of the collateral, net worth of the borrower and the
borrower's capacity for unforeseen business interruptions or risks.
Americans With Disabilities Act
The Americans With Disabilities Act ("ADA") enacted by Congress, in
conjunction with similar California legislation, is having an impact on
banks and their cost of doing business. The legislation requires
employers with 15 of more employees and all businesses operating
"commercial facilities" or "public accommodations" to accommodate
disabled employees and customers. The ADA has two major objectives (1)
to prevent discrimination against disabled job applicants, job
candidates and employees and (2) to provide disabled persons with ready
access to commercial facilities and public accommodations. Commercial
facilities, such as the Bank, must ensure all new facilities are
accessible to disabled persons, and in some instances may be required to
adapt existing facilities to make them accessible, such as ATM's and
bank premises.
New and Pending Legislation
Certain legislative and regulatory proposals that could affect the
Corporation, the Bank and the banking business in general are pending or
have been introduced, before the United States Congress, the California
State Legislature, and Federal, state and local government agencies.
(a) ATM Fees. Legislation has been proposed in the past in the
Congress and the California legislature and measures are currently being
proposed in local jurisdictions to regulate the amount of ATM fees that
operators of ATMs may charge, and to further regulate the disclosure of
such fees. The Gramm-Leach-Bliley Act of 1999 also requires ATM
operators who impose a fee for use of an ATM by a non-customer to
disclose such fees. The Bank does not own or operate ATM machines.
(b) Expansion in Credit Union Membership. A broad rule adopted by the
National Credit Union Administration ('NCUA'), relaxes limits of credit
union membership. The new rule took effect January 1, 1999. The NCUA
will now approve credit unions with membership of more than 300,000
residents with proof that they function as a community. The effect is
to substantially expand credit union membership and make credit unions
as tax exempt entities, serving credit needs of large communities, more
competitive to banks. Litigation attacking the new rule is pending.
(c) Privacy. The 1996 Amendments to the Fair Credit Reporting Act
allow a bank to share customer information with its affiliates providing
the bank's customers are given the opportunity to 'opt out' by way of
language contained in a bank's loan applications, loan agreements and
other forms. The Gramm-Leach-Bliley Act of 1999 requires financial
institutions to provide further customer protections regarding the
sharing or selling of nonpublic personal information, including
disclosure by an institution of its policies regarding confidentiality
and security of such personal information and further requirements
regarding notices to customers and the customer's opportunity to
exercise a non-disclosure option. Regulations to implement these
requirements were adopted by the regulatory agencies in May, 2000 for
which compliance is optional until July 2001. California state law
provides protection against furnishing customer information to third
parties (other than law enforcement officials).
It is not known to what extent, if any, these proposals will be enacted
or remain in force or what effect such legislation would have on the
structure, regulation and competitive relationship of financial
institutions. It is likely, however, that many of these proposals would
subject the Corporation and the Bank to increased regulation, disclosure
and reporting requirements and would increase competition to the Bank
and its cost of doing business.
In addition to pending legislative changes, the various banking
regulatory agencies frequently propose rules and regulations to
implement and enforce already existing legislation. It cannot be
predicted whether or in what form any such legislation or regulations
will be enacted or the effect that such legislation or regulations may
have on the Bank's business. It is likely, however, that many of these
proposals would subject the Corporation and the Bank to increased
regulation, disclosure and reporting requirements and would increase
competition to the Bank and its cost of doing business.
ITEM 2. Properties
The Corporation and the Bank share common quarters at 801 Fourth Street,
in the central business district of Santa Rosa. The Corporation leases
a total of approximately 9,335 square feet of ground floor and second
floor office space at that location and sublets this area to the Bank.
The SBA and Commercial Lending and Loan Administration offices are
located less than a block away from the main office at 815 Fifth Street,
Santa Rosa. The Bank leases 8,047 square feet from Mr. James Ratto, a
major shareholder of the Corporation.
The Corporation leases facilities for its five branch offices in Sonoma
County under various leases which expire under various dates, including
options to renew through the year 2025.
The Bank also leases other property for its supermarket branches in
Sonoma County and loan production offices in California and Arizona.
The Bank has signed a lease to be used as an operation center. The data
processing, bookkeeping, personnel and finance departments will be
relocating to the new facility during the third quarter of 2001. By
relocating these functions the Bank will have adequate facilities at the
Main Branch and the Lending and Loan Administration facilities to meet
present needs. Additional, facilities may be needed based upon the
expansion of the Bank.
The Bank has invested in loans secured by real property collateral. The
Bank's policies with respect to such loans are described under the
caption "Item 7, Management's Discussion and Analysis of Financial
Condition and Results of Operation - Loan Portfolio."
ITEM 3. Legal Proceedings
Neither the Corporation nor the Bank is a party to any material pending
legal proceedings, other than proceedings arising in the ordinary course
of the Bank's business. None of these are expected to have a material
adverse impact on the financial position or results of operations of the
Corporation or Bank.
ITEM 4. Submission of Matters to a Vote of Security Holders.
There were no matters submitted to a vote of shareholders during the
fourth quarter of 2000.
Part II
ITEM 5. Market for Registrant's Common Equity and Related Stockholder
Matters
On February 15, 2001, the Corporation had 3,768,146 shares of common
stock outstanding, held by approximately 301 shareholders of record.
At February 15, 2001, the directors and officers of the Corporation and
the Bank hold 11.2% and beneficially own 35.6% of the outstanding
shares. See "Item 12, Security Ownership of Certain Beneficial Owners
and Management," herein. Under SEC rules, the directors and officers
are restricted in the amount of securities they may sell without
registration under the Securities Act of 1933, as amended. In general,
directors and officers each may offer up to 37,681 shares in any three
month period without such registration.
As of February 15, 2001, the directors, officers and staff also have the
right to acquire 1,097,003 additional shares upon the exercise of
options granted pursuant to the Corporation's Stock Option Plans.
Should several directors and officers choose to exercise options and
sell their shares on the market, such that a large number of shares are
offered at one time, the price of the common stock could be adversely
affected.
The Corporation's common stock is not listed on any securities exchange
or on the National Association of Securities Dealers Automated
Quotations (NASDAQ) System. The firms First Union Securities, Inc. and
Mutual Securities, located in Santa Rosa, and Hoefer & Arnett and First
Security Van Kasper, located in San Francisco, are presently making a
market in the stock. The Corporation's trading symbol is NREB. The
following chart shows the high and low bid quotations and the volume of
transactions in the Corporation's stock for the periods indicated. The
volume information has been provided to the Corporation by Hoefer &
Arnett of transactions reported to NASDAQ and does not include privately
negotiated transactions. After September 30, 2000, the trading volume
was obtained from the OTC bulletin board web site. The prices provided
by Mutual Securities are inter-dealer prices, do not necessarily
represent actual transactions and do not include retail mark-ups,
mark-downs or commissions. After September 30, 2000, the prices were
obtained the from the business section of the Press Democrat. The bid
prices and numbers of shares in this table have been adjusted for the
impact of the stock dividends issued during 1999 and 2000.
Bid Quotations for the Corporation's Common Stock
Approximate
High Low Trading Volume
---- ---- --------------
Quarter Ended
March 31, 1999 18.08 12.48 440,228
June 30, 1999 17.38 16.19 125,265
September 30, 1999 17.03 16.31 81,900
December 31, 1999 18.70 15.83 289,275
March 31, 2000 18.57 13.81 196,245
June 30, 2000 15.63 13.88 135,250
September 30, 2000 16.75 14.50 242,500
December 31, 2000 18.75 16.50 130,930
Due to the lack of any significant trading and no established public
market, the prices indicated above should not be considered an
indication of the market value of the shares. There is no assurance
that any significant trading market for the shares will develop in the
future and there are no assurances as to the price at which shares may
be traded in the future. The bid and asked prices of the Corporation's
common stock were $21.62 and $22.12, respectively, on February 15, 2001.
Dividends
On March 21, 2000, the Corporation declared a 5% stock dividend to
shareholders of record on May 3, 2000. On April 6, 1999, the
Corporation declared a 5% stock dividend to shareholders of record on
May 18, 1999.
The Corporation has not paid any cash dividends since 1995. There is no
assurance that dividends will be paid, or, if paid, what the amount of
any such dividends will be. The future dividend policy of the
Corporation is subject to the discretion of the Board of Directors and
will depend upon a number of factors, including earnings, financial
condition, cash needs and general business conditions. In addition, the
Board of Directors may declare dividends only out of funds legally
available therefor. See "Supervision and Regulation - Dividends Payable
by the Corporation."
The Corporation's primary source of income (other than interest income
earned on the Corporation's other investments) is the receipt of
dividends from the Bank. The Bank's ability to pay dividends is subject
to the restrictions of the national banking laws and, under certain
circumstances, the approval of the Comptroller of the Currency. A
national bank may not pay dividends from its capital. All dividends
must be paid out of net profits then on hand, after deducting for
expenses, including losses and bad debts. A national bank is also
prohibited from declaring a dividend until its surplus fund equals the
amount of its capital stock or, if the surplus fund does not equal the
amount of its capital stock, until one-tenth of the bank's net profits
for the preceding half year, in the case of quarterly or semiannual
dividends, or the preceding two consecutive half-year periods, in the
case of an annual dividend, are transferred to the surplus fund each
time dividends are declared.
The approval of the Comptroller is required if the total of all
dividends declared by a bank in any calendar year will exceed the total
of its net profits of that year combined with its retained net profits
of the two preceding years, less any required transfers to surplus or a
fund for the retirement of any preferred stock which may be outstanding.
Moreover, the Comptroller may prohibit the payment of dividends which
would constitute an unsafe and unsound banking practice. As of December
31, 2000, $11,621,000 of retained earnings of the Bank was available for
the payment of dividends under this requirement.
ITEM 6. Selected Financial Data
(Dollars in thousands)
Year ended December 31, 2000 1999 1998 1997 1996
--------- -------- --------- --------- ---------
Interest income $39,894 $29,824 $25,399 $20,645 $16,423
Interest expense 19,495 12,836 11,103 9,191 7,191
Net interest income 20,399 16,988 14,296 11,454 9,232
Provision for loan losses 960 800 480 650 420
Non-interest income 1,456 1,572 1,702 1,403 1,620
Non-interest expense 9,530 8,428 7,582 6,716 6,407
Income before income taxes 11,365 9,332 7,936 5,491 4,025
Provision for income taxes 4,513 3,754 3,171 2,218 1,719
Net Income 6,852 5,578 4,765 3,273 2,306
Earnings per share:
Basic* $1.82 $1.50 $1.31 $0.91 $0.63
Diluted* $1.75 $1.41 $1.26 $0.90 $0.62
Per Share:
Cash Dividends paid $0.00 $0.00 $0.00 $0.00 $0.00
Book value at December 31* $9.59 $7.77 $6.20 $4.92 $4.04
Average common shares outstanding* 3,760,230 3,719,153 3,639,856 3,578,749 3,655,219
Average diluted common shares outstanding* 3,915,841 3,951,941 3,770,284 3,644,465 3,698,864
Shares outstanding at December 31 (Actual) 3,766,382 3,560,296 3,309,712 1,555,069 1,461,400
At December 31
Loans, net 432,446 357,225 267,029 204,408 165,681
Total assets 494,390 397,928 322,253 233,737 224,793
Total deposits 453,437 357,867 295,969 214,747 209,235
Borrowed funds 1,828 9,050 1,872 0 0
Shareholders equity 36,103 29,062 22,810 17,709 14,338
Financial Ratios:
For the year:
Return on average assets 1.54% 1.59% 1.69% 1.43% 1.26%
Return on average equity 20.87% 21.62% 23.39% 20.30% 17.57%
Net interest margin 4.71% 5.03% 5.23% 5.22% 5.31%
Net loan losses to average loans 0.01% 0.01% 0.00% 0.08% -0.04%
Efficiency ratio 43.60% 45.41% 47.39% 52.24% 59.04%
At December 31
Equity to assets 7.30% 7.30% 7.08% 7.58% 6.38%
Total capital to risk adjusted assets 10.69% 10.54% 10.63% 10.95% 10.44%
Nonperforming assets to total loans & OREO 0.51% 0.52% 0.02% 0.29% 0.47%
Nonperforming assets to total assets 0.46% 0.47% 0.02% 0.26% 0.35%
Allowance for loan losses to total loans 1.06% 1.04% 1.11% 1.22% 1.20%
Allowance for loan losses to non-performing
assets 207.58% 200.58% 4869.35% 542.52% 466.21%
* Prior years have been adjusted for stock dividends and stock split
during 1997, 1998, 1999, and 2000.
ITEM 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations
The Corporation's sole subsidiary is Sonoma National Bank ("Bank"), and
its primary activities are the
commercial banking activities engaged in through the Bank. The
following discussion of financial condition and results of operations
focuses primarily on the Bank, for the years ended December 31, 1999 and
2000.
During 2000, total consolidated assets grew 24.2% to $494,390,000 at
December 31, 2000. Total consolidated assets grew 23.5% during 1999 to
$397,928,000 at December 31, 1999. The growth in both years results
from strong loan demand. See discussion on Loan Portfolio.
Total deposits increased 26.7% to $453,437,000 when comparing December
31, 2000 to December 31, 1999. For the year ended December 31, 1999,
total deposits increased 20.9% to $357,867,000. Deposits increased to
fund the loan growth mentioned above. See discussion on Deposits.
Results of Operations Summary
The Corporation's consolidated net income for the year ended December
31, 2000 was $6,852,000 as compared to $5,578,000 for the year ended
December 31, 1999, an increase of 22.8%. The Corporation's consolidated
net income for the year ended December 31, 1999, increased 17.1% over
the year ended December 31, 1998.
Net interest income before provision for loan losses increased
$3,411,000, or 20.1%, when comparing the year of 2000 to 1999. This
increase results from the growth in the volume of loans on which the
Bank earns a net interest margin. The Bank's interest margin for 2000
equaled 4.71% compared to 5.03% in 1999 and 5.23% in 1998. See, "Net
Interest Income."
The provision for loan losses increased $160,000 in 2000 over 1999.
See, "Allowance for Loan Losses." Non-interest income decreased
$116,000 primarily due to a decrease in the amount of $112,000 in
service charges on deposits. See, "Non-Interest Income." Operating
expenses increased by $1,102,000 primarily because of growth of the
Bank. A new branch office was opened in Petaluma, California in
November 2000 and 2000 was the first full year of operation of the
Sebastopol branch which opened in December 1999.
When comparing 1999 to 1998 the provision for loan losses increased
$320,000 from $480,000 in 1998 to $800,000 in 1999 and other income
decreased $130,000 from $1,702,000 in 1998 to $1,572,000 in 1998.
Operating expenses increased $846,000 during 1999 primarily due to
increases in personnel costs, a new branch office and the relocation of
the lending staff to larger space.
Net Interest Income
The primary source of the Bank's income is the difference between (1)
the interest earned on its loan and investment portfolios, interest
bearing deposits with other banks, and federal funds sold, and (2) the
interest paid on deposits and other borrowed funds. This difference is
referred to as net interest income, and it is one of the primary factors
that affect the Corporation's profitability. Interest income earned on
loans, which includes loan fee income, is primarily a function of the
amount of loans outstanding and the rates prevailing on these loans.
Interest paid on deposits depends on the composition of the deposit base
and the rates paid to attract deposits. See, "Deposits."
For the year ended December 31, 2000, net interest income before the
provision for loan losses totaled $20,399,000 as compared to $16,988,000
for the year ended December 31, 1999, representing an increase of 20.1%.
The majority of this increase results from the net margin earned on
growth in the loan portfolio, largely from the increase in commercial
real estate and construction loans. See, "Loan Portfolio." During
1999, net interest income before the provision for loan losses increased
$2,692,000 or 18.8%, from $14,296,000 in 1998 to $16,988,000, primarily
due to the net margin earned on growth in the loan portfolio.
The Bank's net interest margin (expressed as a percentage, the yield on
average interest earning assets less the rate paid on average interest
bearing liabilities) moved from 5.23% in 1998 to 5.03% in 1999 to 4.71%
in 2000. Several factors impact the Bank's net interest margin. These
include changes in market interest rates, level of loans relative to
deposits, mix of loan and earning assets, non-accrual loan balances and
mix of deposits and other funding sources.
Changes in Market Interest Rates
Changes in economic condition and actions of Federal Reserve Board to
the Fed Funds and Discount rates have a direct impact on the Bank's net
interest margin since prime rate generally moves with Federal Reserve
Board changes. During 2000 prime rate increased from 8.5% at December
31, 1999 to 9.5% at year end. During January 2001, the Federal Reserve
Board dropped the Fed Funds rate by 100 basis points which resulted in
the prime rate declining to 8.5%. There are no assurances that earnings
will not be adversely impacted by future actions of the Federal Reserve
Board and changes in market interest rates.
Since the Bank is asset sensitive, meaning more assets are immediately
adjustable than liabilities, the net interest margin tends to increase
when rates increase and tends to decrease in a declining rate
environment.
The full impact of rate changes on the Bank's earnings are not realized
for several months, since not all loans or deposits reprice immediately.
The majority of SBA loans are tied to the prime rate and reprice on a
calendar quarter basis. The Bank has adjustable rate loans, mainly
commercial real estate loans, that are tied to indexes which adjust at a
slower pace, such as the Eleventh District Cost of Funds Index (COFI).
The COFI index moved from 4.66% for December 1998 to 4.85% for December
1999 to 5.62% for December 2000. The Bank also has a fixed rate loan
portfolio which generally reduces net interest margin as interest rates
rise.
Level of Loans Relative to Deposits
The net interest margin is also affected by the level of loans relative
to deposits. The Bank's ratio of loans-to-deposits increased during
2000, when it averaged 98.2%, as compared to 96.1% in 1999 and 94.9% in
1998. An increase in the loan-to-deposit ratio generally results in
increased net interest margin.
Mix of Loan and Earning Assets
Changes in the mix of loans also impact the Bank's interest margin. The
Bank grew average loans by $91.2 million in 2000 and $68.5 million in
1999. In both those years the majority of the growth occurred in
commercial real estate loans. Increases of $80.5 and $49.4 million,
respectively which bear the lowest average interest yield of 8.93% in
2000 and 8.90% in 1999. The majority of commercial real estate loan
rates are tied to COFI and generally adjust every six months which is a
major factor in explaining why the yield moved up only 3 basis points.
Late in 1999, the Bank made a group of apartment loans (approximately
$20 million) which were tied to COFI with a lower interest margins than
other commercial real estate loans. The impact of these lower rates and
the slower repricing schedule of COFI loans negatively impacted the
Bank's interest margin.
Average SBA loans yields for 2000 increased 95 basis points over last
year. The majority of these loans reprice to prime rate on a quarterly
repricing schedule.
Construction loans grew $8.2 million during 2000. The average yield was
10.35% during 2000 compared to 10.41% in 1999. These loans have short
maturity dates (approximately one year). Rates competition for
construction loans has been strong within our market area.
Interest income increased from $25.4 million in 1998 to $29.8 million in
1999 to $39.9 million in 2000. This is a direct result of growth in
loans. Average loans increased from $239.5 million in 1998 to $308.0
million in 1999 to $399.2 million in 2000. The yield on loans fluctuated
from 9.85% in 1998 to 9.20% in 1999 to 9.47% in 2000. The 65 basis
point decline during 1999 resulted primarily from the mix in loans and
the lag in repricing COFI loans. In 2000 the Bank experienced the
benefit of increasing rates on prime based loans with the repricing
benefit of COFI loans still to be realized. The Bank continues to
experience increased competition for loans, which has resulted in lower
loan pricing in the market place, and may impact the Bank's offering
rates on new loans in the future.
Overall loan portfolio yields are affected by deferred loan fees and
discounts on loans. These fees and discounts are amortized to income
over the life, or estimated life, of the loan with which they are
associated and serve to increase loan portfolio yields. Interest income
on loans includes loan fee income of $1,403,000 for the year ended
December 31, 2000, $1,246,000 for the year ended December 31, 1999 and
$1,095,000 for the year ended December 31, 1998. This fee income
increased yields on average loans by 35 basis points in 2000, as
compared to 40 basis points in 1999. Deferred loan fees are a product
of origination and commitment fees net of certain direct loan
origination costs. The deferred fee amounts equaled $2,366,000 at
December 31, 2000, and $2,122,000 at December 31, 1999. Deferred fees
are netted against total loans in the balance sheet.
Discounts on the unguaranteed portion of SBA loans are recorded as an
asset when the guaranteed portion of the SBA loan is sold. These
discounts are amortized as an adjustment to the loan yields over the
estimated life of the SBA loan. As of December 31, 2000, $594,000 was
recorded as discounts compared to $568,000 at December 31, 1999. These
discounts are netted against total loans in the balance sheet.
Non-Accrual Loan Balances
Loans carried as non-accrual reduce the portfolio yield, since the
balance of a non-accrual loan is maintained in the loan total but no
interest is accrued. Non-accrual loans are included in the loan amounts
in the average balance sheets below. Interest foregone on non-accrual
loans equaled $186,000 during 2000 compared to $60,000 during 1999 and
$12,000 in 1998 which had a negative impact on the net interest margin.
The allowance for loan losses has no direct effect on yield. For further
discussion see "Allowance for Loan Losses."
Mix of Deposits and Other Funding Sources
Interest expense increased 51.9% when comparing 1999 to 2000, due to
increases in interest bearing deposits, particularly in time deposits
which bear the highest cost. The average cost of interest paid on
interest bearing deposits for the year ended December 31, 2000 was 5.39%
versus 4.62% for the year ended December 31, 1999. Deposit costs
increased at a significantly faster rate than loan yields during 2000.
Deposit costs rose 77 basis points with loan yield increasing only 27
basis points which had a major impact on the net interest margin for
2000.
The Bank's money market rate account, the Sonoma Investors Reserve
Account remained competitive and grew $28.9 million during 2000.
Balances held in Sonoma Investors Reserve accounts increased from $87.0
million December 31, 1998 to $97.5 million at December 31, 1999 and
$126.4 million at year end 2000. Average balances for all money market
accounts at the Bank were $77.5 million for 1998, $87.9 million for 1999
and $118.9 million for 2000. The rate offered on the Sonoma Investors
Reserve account is repriced on a weekly basis. The cost of these funds
had been tied to the 90 day U.S. Treasury Bill. The U.S. Treasury Bill
was very volatile during 2000 which led to the rapid increase in the
interest paid on this account. In November 2000, the Bank changed from
this volatile index to a discretionary rate which will allow the Bank to
manage the cost more effectively and remain competitive in our market
area. Due to the weekly repricing, changes in rates on the Sonoma
Investors Reserve Account had a more immediate impact on the Bank's cost
of funds than changes in rates on time certificates. The cost of funds
on savings and money market accounts equaled 4.06% in 1999 compared to
5.03% in 2000.
The time deposits reprice at a slower pace, since certificates of
deposits usually do not reprice until their maturity dates, which
generally range from six months to eighteen months. Time deposits have
fluctuated from $146.6 million at December 31, 1998 to $132.9 million at
December 31, 1999 to $254.0 million at December 31, 2000. During both
1999 and 2000, the Bank ran several time deposit campaigns at rates
slightly higher than its local competitors. These higher priced
deposits were used to fund the rapid growth in loans. The cost of time
deposits averaged 5.91% in 2000 and 5.26% in 1999 compared to savings
and money market rate accounts which averaged 5.03%in 2000 and 4.06% in
1999. Growth in time deposits which bear the highest cost, has a
negative impact on the Bank's cost of funds and net interest margin.
Average non-interest bearing deposits increased 7.4% in 2000. In 2000
and 1999, the majority of the Bank's growth was funded by time
certificates and money market accounts. The Bank has the ability to
borrow from the Federal Home Loan Bank (FHLB) at cost which is lower
than market rates on deposits. The Bank's borrowing capacity has been
increased to approximately $100 million, based on collateral, as a
result of the restructuring of the FHLB. The Bank has borrowed from the
FHLB to match fund two long term loans ($1.8 million) and has also
borrowed on a short term basis during times of reduced liquidity.
Currently, the Bank uses this line as a contingency source of funds. The
Bank plans to pledge additional collateral which will increase our
borrowing capacity to a level which would allow the Bank to use the FHLB
as a source of funds for loan growth.
The Bank's margin had been relatively stable during 1998 and then
declined in 1999 and 2000. Changes in the mix of loans and deposits,
changes in the ratio of loans-to-deposits, pricing competition and
market rates all impact the Bank's margin. During 1999, the Bank's cost
of funds decreased 5.8%, while the rate earned on loans decreased 7.1%
which negatively impacted income. The Bank's average loans-to-deposits
ratio increased from 94.9% in 1998 to 96.1% in 1999, and this had a
positive impact on net interest margin.
The tables on the following pages (i) summarize the distribution, by
amount, of the average assets, liabilities and shareholders' equity of
the Corporation for the periods indicated and (ii) set forth the yields
on earning assets and the rates paid for interest bearing liabilities
during the periods indicated. Averages are computed primarily from
daily balances.
AVERAGE BALANCE SHEET
Year Ended
December 31, 2000
(dollars in thousands)
Interest Average
Average Income Yield
Balance /Expense /Rate
------- -------- -------
Certificates of deposit
with other banks $498 $35 6.95%
Investments 3,908 229 5.85%
Federal funds sold 29,382 1,814 6.18%
Loans:
Commercial (including SBA loans) 124,131 12,694 10.23%
Installment loans to individuals 1,701 178 10.45%
Real estate - Construction 37,215 3,850 10.35%
Real estate - Other 236,123 21,094 8.93%
------- -------- -------
Total Loans 399,170 37,816 9.47%
------- -------- -------
Total earning assets 432,958 39,894 9.21%
--------
Non-earning assets:
Allowance for loan losses (4,227)
Deferred Loan Fees & Discounts (2,780)
Cash and due from banks 11,322
Other assets 8,466
-------
TOTAL ASSETS $445,739
=======
Deposits:
Demand - interest bearing $17,012 178 1.04%
Savings & money market 118,942 5,981 5.03%
Time certificates 221,797 13,116 5.91%
------- -------- -------
Total interest bearing deposits 357,751 19,275 5.39%
Other Interest bearing liabilities 3,736 220 5.88%
------- -------- -------
Total Interest bearing deposits &
liabilities 361,487 19,495 5.39%
--------
Non-interest bearing liabilities:
Non-interest bearing deposits 48,655
Other liabilities 2,758
Shareholders' equity 32,839
-------
TOTAL LIABILITIES
AND SHAREHOLDERS' EQUITY $445,739
=======
Net interest income $20,399
========
Net interest margin 4.71%
========
AVERAGE BALANCE SHEET
Year Ended
December 31, 1999
(dollars in thousands)
Interest Average
Average Income Yield
Balance /Expense /Rate
------- -------- -------
Certificates of deposit
with other banks $0 $0
Investments 5,170 275 5.31%
Federal funds sold 24,772 1,203 4.86%
Loans:
Commercial (including SBA loans) 121,650 11,292 9.28%
Installment loans to individuals 1,738 186 10.68%
Real estate - Construction 29,020 3,022 10.41%
Real estate - Other 155,605 13,846 8.90%
------- -------- -------
Total Loans 308,013 28,346 9.20%
------- -------- -------
Total earning assets 337,955 29,824 8.82%
-------
Non-earning assets:
Allowance for loan losses (3,328)
Deferred Loan Fees & Discounts (2,286)
Cash and due from banks 10,550
Other assets 7,105
-------
TOTAL ASSETS $349,996
=======
Deposits:
Demand - interest bearing $15,833 $176 1.11%
Savings & money market 92,468 3,750 4.06%
Time certificates 167,224 8,794 5.26%
------- ------- -------
Total interest bearing deposits 275,525 12,720 4.62%
Other Interest bearing liabilities 2,132 116 5.44%
------- -------- -------
Total Interest bearing deposits
& liabilities 277,657 12,836 4.62%
--------
Non-interest bearing liabilities:
Non-interest bearing deposits 44,656
Other liabilities 1,882
Shareholders' equity 25,801
-------
TOTAL LIABILITIES
AND SHAREHOLDERS' EQUITY $349,996
=======
Net interest income $16,988
=======
Net interest margin 5.03%
=======
AVERAGE BALANCE SHEET
Year Ended
December 31, 1998
(dollars in thousands)
Interest Average
Average Income Yield
Balance /Expense /Rate
------- -------- -------
Certificates of deposit
with other banks $ 0 $ 0
Investments 5,660 332 5.87%
Federal funds sold 28,047 1,466 5.23%
Loans:
Commercial (including SBA loans) 113,108 11,357 10.04%
Installment loans to individuals 1,761 193 10.99%
Real estate - Construction 18,473 2,142 11.59%
Real estate - Other 106,207 9,909 9.32%
------- -------- -------
Total Loans 239,549 23,601 9.85%
------- -------- -------
Total earning assets 273,256 25,399 9.29%
--------
Non-earning assets:
Allowance for loan losses (2,765)
Deferred Loan Fees & Discounts (1,992)
Cash and due from banks 8,072
Other assets 6,181
-------
TOTAL ASSETS $282,752
=======
Deposits:
Demand - interest bearing $12,608 $134 1.06%
Savings & money market 81,359 3,395 4.17%
Time certificates 132,938 7,568 5.69%
------- -------- -------
Total interest bearing deposits 226,905 11,097 4.89%
Other Interest bearing liabilities 130 6 4.61%
------- -------- -------
Total Interest bearing deposits &
liabilities 227,035 11,103 4.89%
--------
Non-interest bearing liabilities:
Non-interest bearing deposits 33,917
Other liabilities 1,426
Shareholders' equity 20,374
-------
TOTAL LIABILITIES
AND SHAREHOLDERS' EQUITY $282,752
=======
Net interest income $14,296
========
Net interest margin 5.23%
========
The following tables set forth the changes in net interest income due to
changes in interest rates and the volume of assets and liabilities
between years. Variances attributable to simultaneous rate and volume
changes are all allocated to volume change amount.
ANALYSIS OF VOLUME AND RATE CHANGES
ON NET INTEREST INCOME AND EXPENSE
2000 OVER 1999
(dollars in thousands)
Volume Yield/Rate Total
------ ------ -------
Increase/(decrease) in interest income:
Certificates of deposit with other banks $35 $ - $35
Investments (67) 21 (46)
Federal funds sold 223 388 611
Loans:
Commercial (incl. SBA loans) 223 1,179 1,402
Installment loans to individuals (4) (4) (8)
Real estate - Construction 850 (22) 828
Real estate - Other 7,177 71 7,248
------ ------ -------
Total 8,437 1,633 10,070
------ ------ -------
Increase/(decrease) in interest expense:
Deposits & other interest bearing
liabilities:
Demand - interest bearing 14 (12) 2
Savings & money market 1,077 1,154 2,231
Time certificates 2,880 1,442 4,322
Other interest bearing liabilities 88 16 104
------ ------ -------
Total 4,059 2,600 6,659
------ ------ -------
Increase/(decrease) in net interest income $4,378 $(967) $3,411
====== ====== ======
ANALYSIS OF VOLUME AND RATE CHANGES
ON NET INTEREST INCOME AND EXPENSE
1999 OVER 1998
(dollars in thousands)
Volume Yield/Rate Total
------ ------ -------
Increase/(decrease) in interest income:
Certificates of deposit with other banks $0 $0 $0
Investments (28) (29) (57)
Federal funds sold (171) (92) (263)
Loans:
Commercial (incl. SBA loans) 860 (925) (65)
Installment loans to individuals (2) (5) (7)
Real estate - Construction 1,222 (342) 880
Real estate - Other 4,591 (654) 3,937
------ ------ -------
Total 6,472 (2,047) 4,425
------ ------ -------
Increase/(decrease) in interest expense:
Deposits & other interest bearing
liabilities:
Demand - interest bearing 34 8 42
Savings & money market 457 (102) 355
Time certificates 1,945 (719) 1,226
Other interest bearing liabilities 92 18 110
------ ------ -------
Total 2,528 (795) 1,733
------ ------ -------
Increase/(decrease) in net interest income $3,944 ($1,252) $2,692
====== ====== ======
Provision for Loan Losses
The provision for loan losses was $960,000 for 2000, compared to
$800,000 in 1999 and $480,000 in 1998. The increase in the provision
reflects the overall growth in loans and the increase in non-accrual
loans during this year. For further discussion see "Allowance for Loan
Losses."
Non-Interest Income
Non-interest income equaled $1,456,000 in 2000 compared to $1,572,000 in
1999 and $1,702,000 in 1998. The following table sets forth income by
category for the years indicated.
Years ended December 31,
(Dollars in thousands) 2000 1999 1998
------- ------- -------
Gain on SBA loan sales $451 $475 $619
Service charges on deposits 332 444 367
Loan servicing fees 285 301 347
Merchant and other service fees 137 152 117
Income on insurance policies 128 105 105
Discount brokerage 8 19 72
Gain on OREO sales 39 (2) 1
Other 76 78 74
------- ------- -------
Total Other Income $1,456 $1,572 $1,702
======= ======= =======
Non-interest income is derived primarily from gains on sales of SBA
loans, service charges on deposit accounts, earnings on life insurance
and SBA loan servicing fees. When comparing the year ended December 31,
2000 to December 31, 1999, non-interest income decreased 7.9% to
$1,456,000, compared to $1,572,000 in 1999. This decline results
primarily from lower service charges on deposit accounts see discussion
below under "Service Charges on Deposits." When comparing the year
ended December 31, 1999 to December 31, 1998, non-interest income
decrease 7.6% to $1,572,000, compared to $1,702,000 in 1998. This
decline results primarily from lower income on SBA loan sales.
Gains on SBA Loan Sales
Gains on the sale of the guaranteed portion of SBA loans decreased to
$451,000 in 2000 versus $475,000 in 1999. This decrease in gains on
sales resulted from a decline in the premium offered by the secondary
market. Due to the general strength of the economy and low interest
rate environment over the last few years, SBA borrowers had been
refinancing in order to take advantage of lower rates and increased
equity of their collateral. Due to these prepayments the yields to
investors had declined and premiums were reduced. The Bank's premiums
averaged 4.10% in 2000 compared to 5.40% in 1999 and 9.4% during 1998.
During 2000, the Bank sold SBA loans totaling $11,004,000, compared to
$10,017,000 in 1999 and $7,144,000 in 1998.
Service Charges on Deposits
Non-interest income includes service charges on deposit accounts.
During 2000, service charges totaled $332,000 versus $444,000 in 1999.
Service charges vary depending upon the customers' uses of various Bank
services. During 1999, the Bank had a customer who typically had high
service charges based upon the account balances and the services
provided. That customer moved their banking relationship to another
financial institution which resulted in a noticeable decline in service
charge income. In addition, the earnings credit rate during 1999 was
lower than it was during 2000 which meant that account holders' earnings
were lower to cover the cost of services. This resulted in higher
services charges during 1999. Additionally, our business account
holders have learned to manage their accounts activity to minimize their
service charges, resulting lower service charges on business accounts.
Loan Servicing Fees
SBA servicing fees decreased to $285,000 for 2000 compared to $295,000
for 1999 and $339,000 for 1998. Service fee income is based on loan
payments and loan payoffs received, and therefore, varies from year to
year. During 2000, the Bank's average SBA loan portfolio serviced was
$30.3 million versus $25.3 million for 1999 and $28.7 million in 1998.
The fluctuation in the serviced portfolio is caused by timing of SBA
loan payoffs and sales.
There can be no assurance that the SBA program will continue to generate
significant amounts of other non-interest income in the future. The
Bank continues to experience additional competition with more financial
institutions making SBA loans. The government may also revise the SBA
program at any time, which could have a negative impact on the Bank's
profit. See, "Item 1, The Corporation, Business of the Bank."
Income on Insurance Policies
Non-interest income also includes earnings on life insurance held for
certain directors and senior officers which totaled $128,000 in 2000
versus $105,000 in 1999.
Discount Brokerage
Discount brokerage services generated $8,000 in 2000 compared to $19,000
in 1999 and $72,000 in 1998. This service was well received by Bank
customers; however, due to the risk associated with discount brokerage
services it was determined that the Bank would no longer offer this
service effective January 1999 which accounts for the decline in income
from this source. The Bank continues to receive a monthly fee on the
open accounts which had been created during the time this service was
offered.
Gain on OREO Sales
During 2000, $39,000 in gain on sale of other real estate owned (OREO)
was recorded compared to a $2,000 loss in 1999 and $1,000 gain in 1998.
See, "Other Real Estate Owned."
1999 compared to 1998
Non-interest income for 1999 totaled $1,572,000, compared to $1,702,000
in 1998. The decrease in gains on the sale of the guaranteed portions
of SBA loans, which totaled $475,000 in 1999 compared to $619,000 in
1998 negatively impacted non-interest income. SBA servicing fees
decreased during 1999 to $295,000 compared to $339,000 in 1998. During
1999, discount brokerage services added $19,000, before expenses.
Service charges also increased $77,000 during 1999.
Non-Interest Expense
Non-interest expenses include salaries and employee benefits, occupancy,
equipment and the general expenses required for the operation of the
Corporation and the Bank. For the year ended December 31, 2000,
non-interest expenses totaled $9,530,000, an increase of 13.1% over the
previous year. The following table outlines the components of
non-interest expense for the periods indicated:
(In thousands)
Year Ended December 31,
2000 1999 1998
Expense Item ------- ------- -------
Salaries & Employee Benefits $5,468 $4,820 $4,284
Occupancy 855 789 747
Equipment 535 468 521
Advertising/Business
Development/Donations 493 441 365
Outside Customer Services 420 347 278
Director & Shareholder expenses 296 311 296
Deposit and Other Insurance 270 211 198
Postage & courier expenses 222 209 179
Professional Fees 245 165 151
Stationery & Supplies 193 173 148
Telephone expense 163 146 117
Loan expenses 82 135 128
Other 288 213 170
------ ------ ------
TOTAL $9,530 $8,428 $7,582
====== ====== ======
Salaries and Employee Benefits
A portion of the 13.4% increase in salaries and benefits resulted from
staff increases associated with the first full year of operation of the
Sebastopol Branch which opened in December 1999 and the new branch in
Petaluma which opened in November 2000. During 2000 incentive
compensation increased due to increased loan production and deposit
growth. Salaries also included increases for performance and promotions
during the year. The Bank's full time equivalent (FTE) staff positions
equaled 96 in 2000 compared to 83 in 1999 and 76 in 1998.
Occupancy
Occupancy costs increased 12.2% due to the two new branch locations and
annual increases in the rents charged on most facilities.
Equipment
Equipment expenses increased 14.3% to $535,000 in 2000 as our use of
technology continued to expand. In 2000, the Bank implemented a new
teller system which required that each teller have a personal computer
and printer. Our internet banking project commenced mid year and will
be available to our customers in 2001. Equipment costs are expected to
continue to increase during 2001 as the Bank grows and expands it usage
of technology.
Advertising/Business Development/Donations
Advertising and business development costs vary from year to year
depending on the various promotions that have occurred during the year.
These costs include promotion of various Bank services (Telebanc, SBA,
commercial and construction lending and deposit campaigns) and promoting
new locations. The Bank has continued its strong support of the local
community through contributions.
Outside Customer Services
Outside customer services increased from $347,000 in 1999 to $420,000 in
2000. Analysis charges are a major expense included in this category.
Analysis charges are customer expenses for title and escrow services,
check charges, courier and payroll services incurred on behalf of
customers who maintain non-interest bearing deposit balances sufficient
to compensate for these costs. See, "Deposits." While some
non-interest expense is incurred, management feels the contribution of
the non-interest bearing demand accounts toward lowering the overall
cost of funds more than offsets this cost.
Director and Shareholder Expenses
Director and shareholder expenses decreased from $311,000 in 1999 to
$296,000 in 2000. See "Compensation of Directors." Director fees vary
depending upon the number of meetings during the year and director
attendance at those meetings.
Deposit and Other Insurance
Included in Deposit and Other Insurance are Regulatory assessments which
have been increasing over the last several years to $117,000 in 1999 and
to $174,000 in 2000. The Bank's deposit insurance premium is currently
based upon the lowest cost category of zero cents per $100 of insured
deposits. There can be no assurance that the deposit insurance rates
will remain at this low level. Effective in 1997, the Bank was charged
a "Financing Corporation" (FICO) assessment. The annual rate varies
($0.0202 for second half of 2000) and is calculated per $100 of insured
deposits. This cost equaled $35,000 in 1999 and $76,000 in 2000. Also
included is the fee (based upon total assets) assessed by the Office of
the Comptroller of the Currency which equaled $82,000 in 1999 and
$98,000 in 2000 See, "Description of Business-Supervision and
Regulation."
Professional Fees
Professional fees increased from $165,000 in 1999 to $245,000 in 2000.
The Bank's legal costs increased $62,000 during 2000, due to the higher
volume of past due and non-accrual loans and OREO which required legal
assistance. Other professional fees include accounting services,
outside data processing review, loan review services, SBA audit fees and
computer training.
Loan Expenses
Loan expenses vary between years based upon many factors. The Bank
generally charges for direct costs associated with loan originations;
however, broker fees on SBA 7a loans are paid by the Bank. During 2000,
broker fees were included in cost recovery and recorded as part of
deferred fees on loans and amortized as an adjustment to interest income
in accordance with generally accepted accounting principles. Prior to
this year these costs were recorded as a loan expense ($91,000 in 1999
compared to $1,000 in 2000). During 2000, foreclosure costs increased
to $17,000 from $11,000 last year. During 1999, the Bank recovered the
SBA's share of costs associated with managing SBA problem loans. The
Bank had recorded the full amount as expense as the cost was paid. The
net recovery was $30,000 as income during 1999 compared to $4,000 in
2000. Other expenses increased based upon growth in loans.
The other expense categories increased due to growth of the Bank.
Non-interest expenses are expected to increase in 2001 due to the
anticipated growth in the Bank.
The increase in non-interest expenses of 11.1% from the 1998 total of
$7,582,000 to $8,428,000 in 1999 was due primarily to staff incentives
associated with increased volume of loan and deposit activity. The
growth of the Bank with the new branch in Sebastopol and new loan
production office in Walnut Creek resulted in higher costs.
Loan Portfolio
The following table shows the composition of the loan portfolio, by type
of loan, as of the dates indicated.
(In thousands)
December 31,
2000 1999 1998 1997 1996
-------- --------- --------- -------- ---------
Type of Loan
Commercial $118,134 $112,277 $110,468 $91,860 $74,630
Real Estate Construction 46,244 39,523 28,177 10,982 1,533
Real Estate Other 273,298 210,119 131,661 103,936 91,347
Installment Loans to
Individuals 2,412 1,783 1,749 2,012 2,218
-------- --------- --------- -------- ---------
Total, gross 440,088 363,702 272,055 208,790 169,728
-------- --------- --------- -------- ---------
Deferred fees and
discounts, net (2,961) (2,690) (2,007) (1,843) (2,005)
-------- --------- --------- -------- ---------
Total loans net of deferred
fees and discounts 437,126 361,012 270,048 206,947 167,723
Allowance for loan losses (4,681) (3,787) (3,019) (2,539) (2,042)
-------- --------- --------- -------- ---------
TOTAL LOANS, NET $432,446 $357,225 $267,029 $204,408 $165,681
======== ========= ========= ======== =========
The table above illustrates the Bank's emphasis on commercial and real
estate lending. At December 31, 2000 and 1999 commercial loans
comprised 26.8% and 30.9%, respectively, of the Bank's total loan
portfolio. Construction and other real estate loans (combined)
comprised 72.6% and 68.7% on those same dates. Management is aware of
the risk factors in making commercial and real estate loans and is
continuously monitoring the local marketplace as well as performing
annual reviews of this portfolio.
The Bank makes commercial loans primarily to small and medium sized
businesses and to professionals located within Sonoma County with SBA
loans also being generated in California and Arizona. While the Bank
emphasizes commercial lending, management does not believe that there is
any significant concentration of commercial loans to any specific type
of business or industry.
At December 31, 2000, 95% or $416 million of the Bank's loans were
secured by real estate as the principal source of collateral. A
worsening of economic conditions, a decline of real estate values and/or
rising interest rates could have an effect on the value of real estate
securing these loans.
Most of the security for the Bank's loans is located in the area where
the loan is generated. A significant natural disaster impacting those
locations, such as a severe earthquake or widespread flooding, could
disrupt the business of these borrowers and impair the security for the
Bank's loans. Although some of the Bank's borrowers carry insurance to
cover some of the losses that might arise from such an event, the Bank
does not require all its borrowers to carry earthquake insurance
coverage since such insurance typically provides a large deductible
amount. If a large earthquake occurs in the Bank's market area, the
Bank would probably have to restructure some of its loans and may suffer
loan losses related to the earthquake.
The Bank originates loans guaranteed by the U.S. Small Business
Administration ("SBA"). The guaranteed portion of each loan, typically
ranging from 70% to 90%, may be sold to outside investors, usually at a
price in excess of par. Under the new rules the 7(a) guarantees range
from 75% to 85% with a maximum of $1,000,000. The unguaranteed portion
on sold loans is generally retained in the Bank's loan portfolio. The
Bank follows the same internal credit approval process when approving an
SBA loan as when approving other loans. The majority of the Bank's SBA
loans are secured by real estate. All SBA loans are reported in the
chart above as Commercial Loans.
While SBA loans generally have the same underwriting requirements as the
Bank's other loans, they are sometimes for longer terms (7 to 25 years)
and have a higher loan-to-value ratio than the Bank typically accepts.
This risk is mitigated by the majority of the loans being secured by
real estate. If a default on a SBA loan occurs the Bank shares
proportionally in the collateral supporting the loan with the SBA which
guarantees the loan. The SBA department also generates commercial and
construction loans which are not SBA loans. At December 31, 2000, the
Bank held $203,073,000 in loans generated by the SBA department, of
which $93,889,000 were 7(a) loans of which $61,946,000 was guaranteed by
the SBA. At December 31, 1999, the Bank held $165,019,000 in loans
generated by the SBA department, of which $91,838,000 were 7(a) loans of
which $60,948,000 was guaranteed by the SBA. There were no SBA
guaranteed loans more than 90 days past due and still accruing interest:
there were three SBA guaranteed loans totaling $1,791,000, of which
$1,292,000 was guaranteed by the SBA, on non-accrual status, as of
December 31, 2000. There were charge-offs totaling $36,000 on loans with
SBA guarantees during 2000 and no charge offs on SBA guaranteed loans
during 1999 and 1998.
The category entitled "Real Estate-Other" includes loans which are
secured by real estate and not classified as a construction or
commercial loan. The majority of these loans are secured by commercial
real estate. The Bank offers residential mortgage loans on a limited
basis. Home equity lines of credit, included in Real Estate - Other,
equaled 1.1% of the total loan portfolio at December 31, 2000 compared
to 0.7% at December 31, 1999. These loans are secured primarily by
second trust deeds on single family residences. The Bank typically
requires a loan-to-value ratio of no more than 80% for home equity
loans. The rates are adjustable monthly based on the Bank's internal
reference rate, and terms do not exceed ten years.
Real estate construction loans grew from $39,523,000 in 1999 to
$46,244,000 in 2000. The Bank created a construction loan group during
1997 to focus on construction loans primarily for single family
residences valued at under $4,000,000 located in Northern California.
Construction loans are made to "owner/occupied" and "owner/users" of the
properties and occasionally to developers with a successful history of
developing projects in the Bank's market area. Loan-to-value ratios on
construction loans depend upon the nature of the property. The Bank's
policy is to require that the loan-to-value ratio ranges from 65% to 80%
and that the borrower have a cash equity interest in the land ranging
from 25%-50% or alternative collateral. The construction lending
business is subject to, among other things, the volatility of interest
rates, real estate prices in the area and the market availability of
conventional real estate financing to repay such construction loans. A
decline in real estate values and/or demand could potentially have an
adverse impact on this portion of the loan portfolio, and on the
earnings and financial condition of the Bank.
The Bank has a small portfolio of consumer loans, equaling 0.6% of the
total loan portfolio at December 31, 2000. Personal lines of credit and
overdraft protection are offered to customers. Regular underwriting
procedures are followed depending upon the type of loans. Revolving
lines are reviewed every two years.
It is the Bank's policy to collateralize all loans unless, in
management's estimation, the credit worthiness, cash flow and character
of the borrower justify extension of credit on an unsecured basis.
Management recognizes the inherent risk in making unsecured loans, but
in management's judgement, such unsecured loans are justified based on
the credit worthiness and financial strength of the borrowers.
Management believes that its secured loans are adequately collateralized
to minimize loss in the event of default in payment of interest or
principal or decline in collateral values. In making collateralized
loans, the Bank's policy establishes a maximum loan-to-collateral value
ratio of from 50% to 100%, depending on the type of collateral and the
other factors supporting the loan.
The following table summarizes the Bank's loan maturities, by loan type,
at December 31, 2000. Loans are categorized by the maturity of the
final installment.
(In thousands)
Real Estate- Other Real
Commercial Construction Estate Installment Total
---------- ------------ ---------- ----------- -------
Loans Maturing in:
One year or less:
Fixed rate $809 $24,343 $18,707 $80 $43,939
Variable rate 11,916 12,218 2,959 - 27,093
One to five years
Fixed rate 3,035 514 7,340 1,512 12,401
Variable rate 6,812 3,386 20,365 56 30,619
After five years
Fixed rate 1,721 115 19,273 248 21,357
Variable rate 93,841 5,668 204,653 516 304,678
---------- ------------ ---------- ----------- -------
TOTAL $118,134 $46,244 $273,297 $2,412 $440,087
========== ============ ========== =========== ========
Of the total loans due in more than one year at December 31, 2000,
$33,758,000 were at fixed interest rates, which includes loans currently
at their floor rate, and $335,297,000 were at adjustable interest rates.
Interest Rate Sensitivity
The Bank attempts to lend at competitive interest rates and to reduce
exposure to interest rate fluctuations by making most of its loans at
adjustable interest rates.
The following table summarizes the Bank's loan portfolio by contractual
repricing frequency and by loan type, at December 31, 2000. SBA loans
are considered commercial loans for this analysis. Most of the SBA
loans are secured by real estate. The Bank has approximately $16.1
million in adjustable loans which are priced at floor rate and are
considered fixed rate loans, deemed to reprice at their maturity date
for the purpose of this analysis.
(In thousands)
Over 3 Over
3 Months Months 1 Year
or through through Over 5
Less 1 Year 5 Years Years Total
-------- ------- ------- ------ --------
Commercial $110,413 $1,190 $4,809 $1,722 $118,134
Real Estate -Construction 30,353 13,417 2,318 156 46,244
Real Estate -Other 44,754 153,217 55,139 20,187 273,297
Installment Loans 753 22 1,390 247 2,412
-------- -------- ------- ------- --------
TOTAL $183,273 $167,846 $63,656 $22,312 $440,087
======== ======== ======= ======= ========
Interest rate risk is reduced through the practice of making variable
interest rate loans which are tied to an outside rate index. These
loans "float", or adjust their rate as the interest rate environment
changes. As of December 31, 2000 and 1999 approximately 82% and 73%,
respectively, of the Bank's loan portfolio was comprised of loans with
adjustable rates (excluding those which had reached their floors).
Allowance for Loan Losses
In accordance with its policy, the Bank maintains an allowance for loan
losses to provide for losses in the loan portfolio. The allowance for
loan losses is reviewed monthly and is based on an allocation for each
loan category (e.g. Real Estate, Commercial), an allocation for
undisbursed commitments, plus an allocation for any outstanding loans
which have been classified by regulators or internally for the "Watch
List." Each loan that has been classified is individually analyzed for
the risk involved and an allowance provided according to the risk
assessment. In addition, management considers such factors as known
loan problems, historical loan loss experience, loan concentrations,
loan loss experience in the banking industry, evaluations made by bank
regulatory agencies, assessment of economic conditions and other
appropriate data to identify risks in the loan portfolio. Based upon
this analysis of the allowance for loan losses (which incorporates the
growth in the loan portfolio during the year), the Bank has increased
the allowance by 23.6% to $4,680,000 at December 31, 2000 compared to
$3,787,000 in 1999. The provision for loan losses for the year ended
December 31, 2000 was $960,000 as compared to $800,000 for the year
ended December 31, 1999. The increase in the allowance was based upon
the growth in the loan portfolio during the year. The ratio of
allowance to total loans outstanding (net of SBA loan guarantees)
equaled 1.2% at December 31, 2000 and 1.3% at December 31, 1999.
Depending on future evaluations of the allowance in connection with
regulatory examinations, any changes in the factors management reviews
as described above, and the amount of any loan losses that may be
incurred, further increases may be made in accordance with the Bank's
policy, and such increases will have an adverse effect on earnings.
Management attempts to reduce exposure to loss from adverse economic
conditions through portfolio diversification among businesses and types
of borrowers.
The following table sets forth the changes in the allowance for loan
losses over the last five years and the relationship to loans
outstanding, net of the SBA guaranteed portion, at the end of those
periods.
(dollars in thousands)
Year Ended December 31,
ALLOWANCE FOR LOAN LOSSES: 2000 1999 1998 1997 1996
------ ------ ------ ------ ------
Balance at Beginning of Period $3,787 $3,019 $2,539 $2,042 $1,676
Provision for Loan Losses
Charged to Expense 960 800 480 650 420
Less Charge-Offs:
Commercial 0 13 0 48 38
Real Estate-Other 66 0 0 140 0
Consumer loans 0 19 0 34 24
------ ------ ------ ------ ------
Total Charge-offs 66 32 0 222 62
------ ------ ------ ------ ------
Recoveries:
Commercial 0 0 0 69 8
Real Estate - Other 0 0 0 0 0
Consumer 0 0 0 0 0
------ ------ ------ ------ ------
Total Recoveries 0 0 0 69 8
------ ------ ------ ------ ------
Net Charge-offs/(Recoveries) 66 32 0 153 54
------ ------ ------ ------ ------
Balance at the End of the Period $4,681 $3,787 $3,019 $2,539 $2,042
====== ====== ====== ====== ======
Total Loans Outstanding at End of
Period-Net of SBA Guarantees $378,141 $302,665 $213,034 $162,077 $141,472
Ratio of Ending Allowance to
Ending Loans Outstanding-Net
of SBA Loan Guarantees 1.2% 1.3% 1.4% 1.6% 1.4%
AVERAGE TOTAL LOANS $399,170 $308,013 $239,549 $191,292 $148,025
Ratio of Net Charge-offs to
Average Loans Outstanding
During the Period 0.012% 0.010% 0.0% 0.079% 0.036%
During 2000 there were charged-offs on three real estate loans totaling
$66,000 and no loan recoveries.
The following tables set forth the allocation of the allowance for loan
losses by loan type at the end of those periods indicated. The
allocation of the allowance will necessarily change whenever management
determines that the risk characteristics of the loan portfolio have
changed. It should not be construed that the amount allocated to a
particular segment is the only amount available for future charge-offs
that might occur within that segment, since the allowance is a general
reserve. In addition, the amounts allocated by segment may not be
indicative of future charge-off trends. The percentage of loans shown
in these schedules represent the percentage of loans in each loan
category to total loans.
(dollars in thousands)
December 31, December 31, December 31,
2000 1999 1998
% of % of % of
Amount Loans Amount Loans Amount Loans
------ ----- ------ ----- ------ -----
Category
Commercial $1,194 26.8% $1,269 30.8% $1,565 40.6%
Real Estate -
Construction 1,057 10.5 776 10.9 444 10.4
Real Estate -Other 2,383 62.1 1,700 57.8 959 48.4
Installment Loans 47 0.6 42 0.5 51 0.6
------ ----- ------ ----- ------ -----
TOTAL $4,681 100.0% $3,787 100.0% $3,019 100.0%
====== ===== ====== ===== ====== =====
(dollars in thousands)
December 31, December 31,
1997 1996
% of % of
Amount Loans Amount Loans
------ ----- ------ -----
Category
Commercial $1,312 44.0% $1,081 44.0%
Real Estate -
Construction 133 5.2 66 .9
Real Estate -Other 1,021